Editor's note: Today, we're turning things over to Rob Spivey – director of research at our corporate affiliate Altimetry – to learn what gives a company an edge over its competitors. Unique innovations aren't always enough to make a market leader. In this article, adapted from a recent issue of the Altimetry Daily Authority free e-letter, Rob explains which traits set a business above the rest... and why certain types of companies make for great investments.

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Once Apple (AAPL) sinks its claws into you, you're all but trapped...

Your Apple Watch links up to your music library... and allows you to read and respond to iMessages. It's easy to sync content between your MacBook and iPad, which can also act as a second screen.

And with more than 2 billion products in circulation today, Apple has made it easy for all these gadgets to "talk" to one another.

It has spent decades building out a seamless ecosystem. For many of its users, the hassle of setting up a new phone, a new computer, and learning a new system just isn't worth it.

The tech titan doesn't dominate the scene because its products are that much better. (I'll leave that debate to the Apple-versus-PC fanatics.) It's because the cost of switching is simply too high.

Most folks would rather stay in Apple's ecosystem than endure the headache of leaving it... even if it means paying a premium for new Apple products every few years.

As I'll explain today, Apple is a prime example of a business with a key competitive advantage... but it's not the only one.

A lot of times, investors get too caught up in the minutiae. They want to know "how a company makes money"... So they focus on why its products or widgets are slightly better than its competitors'.

But having slightly better products isn't always what makes a company sing.

At Altimetry, we use Uniform accounting to avoid the distortions in traditional accounting methods. And we can see the breadth of Apple's advantage in its earnings numbers...

The company's Uniform return on assets ("ROA") has been above 40%, year in and year out, for the past decade and a half. That's more than triple the corporate average. Take a look...

If you believe that Apple's dominance is because its products are that much better... the company would need to stay ahead of its competitors in terms of innovation. It's the only way it could keep churning out those high returns.

But its biggest competitor in the phone market, Samsung, often introduces tools even earlier than Apple...

Samsung was the first to introduce wireless charging. It was first to let users run two apps at the same time. And it was first to use the universal USB-C charging for its devices.

Yet without the powerful ecosystem that Apple has created, Samsung's returns just aren't as high. Its Uniform ROA has never surpassed 15%...

You might even argue Apple's key strengths lie in its brand. If people started questioning how Apple products define their own aesthetic, its ROA could crater.

The reality is that both innovation and brand recognition have given Apple a boost over the years. But they're not the primary way it keeps its returns high. That honor goes to switching costs.

Apple's ecosystem may not have been how it got those returns 15 years ago... but it's how it keeps them now.

Let's consider another example – Lam Research (LRCX)...

We got interested in Lam Research back in 2016. It's what most folks would call a boring business... It sells parts and components that help chipmakers make their chips. It doesn't even make the chips itself.

As a result, we would've expected its Uniform ROA to be average... somewhere between 6% and 12%. But in late 2016, we saw that its returns were on pace to surpass 20% for the second year in a row.

After doing some more digging, we found that this wasn't just a short-term spike in demand. Lam had something more powerful in its corner.

The company had the best parts for making high-quality memory chips... And more important, it had numerous patents to protect those tools. (Today, that number sits at more than 11,000.)

In other words, nobody else could compete with its parts.

That intellectual-property protection is what gave us confidence in Lam Research's long-term returns.

In February 2020, we recommended Lam Research in our Altimetry's Hidden Alpha monthly advisory. Subscribers who followed our advice secured a 112% gain in less than a year and a half.

Nowadays, many investors and analysts – including us – are using artificial intelligence to help identify this sort of competitive advantage. But you don't need a high-tech machine-learning system to start looking for standout companies.

To spot competitive advantage, you have to determine how a company really makes money.

One of the best ways to determine this is by looking at all the competitors themselves. This allows you to find what sets a particular company apart from the rest. You might notice it's a much larger business, which could mean it has better economies of scale. Or perhaps it has intellectual-property protections like Lam Research.

That's step one. The second step is to focus on how long that competitive advantage will last... and how strong it is.

Most investors spend their time understanding what a company does. But that's not how you get an edge in the markets.

Instead, spend the bulk of your time looking for competitive advantages. You'll learn to spot high-quality companies faster – the ones that can outperform in any kind of market.

Regards,

Rob Spivey

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Editor's note: With the recent volatility, it's harder than ever to tell whether an investment will end up being a success or disaster. But according to Altimetry founder Joel Litman, it's about to get worse... because he says a devastating shift is coming that could potentially make or break your wealth. On Wednesday, December 6, he's sharing an urgent announcement for 2024 that will help you prepare your portfolio for what's coming... Click here to learn the details.